The bigger they come …

The China Crisis: How China’s Economic Collapse Will Lead To A Global Depression. By James R. Gorrie. Wiley, 292 pages

“China, with all its problems, is simply too big not to fail.”

—James Gorrie in The China Crisis

Many will dismiss James Gorrie’s book as an alarmist polemic against the new, but still old, Red China. However, that is too glib a review.

True, Gorrie, a financial writer from Austin, Texas, is predicting the end of the economic world. Yes, he indulges in hyperbole and seems nearly hysterical when writing about communism.

Yet Gorrie is also giving us many of the key metrics and sources for monitoring conditions behind the Bamboo Curtain. And that is a utility not to be overlooked, as China’s slowing economy threatens the values in its land-leveraged, local government financing vehicles.

Gorrie’s thesis is that China’s economic miracle, rather than saving the state and the Chinese Communist Party (CCP), as originally intended after Tiananmen Square, will actually bring the government down. Pollution, graft, nepotism, factionalism, famine, and other unintended dire consequences of the economic expansion will overwhelm any official efforts to mitigate the damage.

The CCP will be forced to cope with an ever-increasing series of cascading crises with domino effects. “Before too long, hundreds of billions, if not trillions, of dollars will be lost in China—and in Chinese companies around the world,” Gorrie predicts.

Is the People’s Republic of China merely a larger version of the old communist state of Yugoslavia, kept intact only by force, likely to explode into factions of religious and cultural disharmony?

“Yes” is the easy answer, but the reality is far more complicated. The West was not nearly so entwined with eastern Europe as it is with China. Yet NATO was forced to intervene after four years of war in Bosnia. A civil war in China could embroil the entire world. Calmly, Gorrie predicts civil war in China as “a distinct possibility.” He sees regional factions in full rebellion against the CCP in Beijing. The land itself will strike back as agricultural collapse follows the extreme pollution, drought, overdevelopment, and overgrazing caused by CCP policies.

Political collapse will result when the Party faces threats from within, Gorrie predicts. Regional authorities will demand military support as resistance grows to “the CCP’s destructive totalitarian rule.”

As the Chinese economic miracle wobbles on its axis, Gorrie predicts that ever-growing demands for energy will press the Chinese military to distract the masses and “adopt a forward-leaning posture toward energy suppliers and an aggressive posture to capture oil-producing areas that are within China’s military grasp.”

Just offshore, Taiwan’s wealth is projected as a likely target for the acquisitive CCP leadership. That’s not good, since the United States is a strategic ally of Taiwan and aggression by the CCP might trigger an armed U.S. response.

Crisis of legitimacy

Legitimate governments, writes Gorrie, don’t need a police state to protect themselves from their own citizens. CCP’s paranoia, as shown by “large-scale censorship, tight restrictions on assembly, a corrupt or nonexistent legal system, unlimited detention without trial, and an advanced internal security service that is not just investigative, but paramilitary and widely present in its exercise in society” is prima facie evidence of the state’s fatal illegitimacy, for the author.

Propping up the government is the corrupt Chinese financial sector, with issues ranging “from false valuations of property and fraudulent profit margins of state-owned companies to fraudulent lending involving non-existent customers, baseless public investment projects undertaken, and inefficient, unnecessary, and poorly constructed infrastructure projects that fulfill no need. The degree of rot in the system is at levels that challenge the imagination.”

Political connections and outright bribery allow wealthy Chinese to avoid paying taxes, thereby creating an inverted fiscal infrastructure. Only one-third of personal income taxes are paid by the upper classes, as compared with the U.S. where four-fifths are paid by the well off. Favoritism of this kind allows CCP to maintain power, but denies a strong domestic consumer to the production sector.

Structural pressures are being felt from rising labor costs, as the middle class demands higher pay, making products from China less competitive with those of its smaller southeast Asian neighbors.

Gorrie notes that economic partnership with the Chinese looks less appealing today: “Even some U.S. firms now find that the labor cost advantage in China has gone away, and consequently they are closing their factories in China and returning their manufacturing plants to the United States, to be manned by American workers.” (Of course, the expected fall in energy costs from the fracking revolution in the U.S. is also bringing back previously outsourced manufacturing jobs.)

Weighing on China’s growing middle class is its aging population.

Gorrie indicts the One-Child policy of 1979 as having reduced the workforce relative to the pension system. Perhaps, but the inadequacy of national pensions is also a global problem. In 2012, there were 20 seniors for every 100 workers in the United States, according to the World Bank, as compared with 12 in China. In Germany, the age dependency ratio is 32:100.

The World Bank agrees that there is “a special urgency” in China as a result of the “race between population aging and pension coverage.”

What’s mine is mine, what’s yours is mine

China’s mix of capitalism and Communism, known as Market-Leninism or the Beijing Model, is “just another variation on the European fascist models of the 1920s and 1930s,” where states controlled the means of production, Gorrie says. However, China’s approach is even more devious, in his view. Once private companies achieve success, the author claims that they are taken over by CCP-affiliated enterprises.

Growing ever more swollen, China’s state-owned companies are, in the author’s view, “a financial black hole that sucks in capital in the form of recurrent debt without returning profit to justify the loans.”

Gorrie’s prose is nothing if not colorful, such as when he writes of “a monster of an economy and a society that is at war with itself, as the state seeks to devour not only the fruits of its capitalist enterprises, but the enterprises themselves, in an orgy of avarice, political corruption, and paranoia.”

Propaganda, distortions, and third-hand facts

Gorrie warns readers that the CCP’s reported GDP numbers are “first and foremost political propaganda tools, not economic tools, as they are in the West.” Disbelieving the official statistics, Gorrie is forced to rely on unofficial sources who claim that growth rates are come nowhere near what Chinese officials claim.

“In fact, Chinese GDP statistics are so distorted as to be unbelievable altogether,” says Gorrie.

Most footnotes in The China Crisis are linked to sources on the web, so it’s easy to review the book in an e-reader and then click on a footnote and jump directly to the original research material. Unfortunately, one finds that many of those sources are Western attacks on Chinese culture or politics. The underlying research for those sources is often based on Western studies, using data from Chinese expatriates or dissidents operating underground in China.

One of Gorrie’s more damaging claims is the assertion that, “China’s elite and ruling class are transferring billions of dollars out of their own country. Why would Party members—those who rule China—be moving what amount to kings’ fortunes outside of their own country, which is purportedly the greatest, most successful economic story for the twenty-first century?”

The primary sources for this criticism are Western publications, including an October 28, 2012 Forbes Magazine blog, which describes “growing anecdotal evidence of hot money leaving China,” partly from unnamed “U.S. Treasury officials [who] have been quietly telling analysts that they noticed a surge in outflows from China beginning in the summer of 2010.”

Gorrie asserts that, “The leaders of the Party are all enormously wealthy, with many having gained personal fortunes in excess of several billions of dollars.” As a source for this statistic, Gorrie cites a February 27, 2012 Bloomberg News story which, in turn, cites a survey by the Shanghai-based Hurun Research Institute. However, Hurun does not reveal its underlying sources for the demographic statistics in its survey, so one is left to wonder about its reliability.

“That the Chinese leadership is hedging their bets against their own country is hardly a stout endorsement of the Beijing Model or of China’s future, is it?” says Gorrie.

If, in fact, the capital flight seems to suggest that the breakup of the country is an increasing risk, China watchers should set their Google Alerts for unrest in China’s western provinces, particularly Tibet and Xinjiang. The Buddhist and Muslim majorities in those countries are restless and dangerous.

Unfortunately, many of the author’s claims lack quantification and are unsubstantiated. Still, Gorrie’s assertions would be alarming enough even if they were only half-truths. His principal conclusion is that, “The contradictions between the two forces in China are great and irreconcilable; in the end, between the CCP and capitalism, there can be only one dominant force in China. Both cannot continue to exist indefinitely.”

At the end of the day, this reviewer’s recommendation is to read Gorrie’s China Crisis with an extra-dry martini—or two or three. His prognosis for China’s influence on global market conditions is far too depressing for sober contemplation.

Ed Blount, a longtime contributing editor, founded the Center for the Study of Financial Market Evolution in 2006. Today he serves as the center's executive director. He has testified as a capital markets expert before all three branches of the U.S. federal government. Apart from his non-profit work, he has been a successful entrepreneur, writer, and consultant for 35 years. When, in 2007, Mr. Blount sold ASTEC Consulting Group to a Fortune 500 data systems vendor, the firm's research cooperatives and online risk/pricing systems were serving 500 institutional investors with counterparty exposures of US$3 trillion. Part of the sale proceeds were deposited in a foundation to fund the Center's activities. Among other writings Blount frequently reviews books for the www.bankingexchange.com's "Books for Bankers" section.